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Italien - Italy

We discussed this several years ago - in a democracy, austerity will eventually fail at the ballot box.
The people will not tolerate 25% unemployment forever - with no hope in sight.
CalculatedRisk, 25 January 2015

Mr Draghi issued his own cri de coeur in Helsinki six weeks ago, laying out the "minimum requirements for monetary union".
His prescription amounts to an EU superstate, with economic sovereignty to be "exercised jointly".His plea is Utopian. There is no popular groundswell anywhere for such a vaulting leap forwardThe northern creditor states have in any case spent the past four years methodically preventing any durable pooling of risk or any step towards fiscal union.
In airing such thoughts, Mr Draghi is really telling us that he no longer thinks EMU can work.
Ambrose Evans-Pritchard 7 Jan 2015

In an act of studied contempt, Mr Renzi’s government published online
the Commission’s “strictly confidential” letter demanding an explanation for Italy’s draft 2015 budget.
Mr Renzi said he wanted greater transparency and would, in future, be publishing not just the Commission’s letters,
“but all the financial data on how much is spent in these buildings. It’ll be a lot of fun.”It is the sort of remark you might expect from a eurosceptic like Nigel Farage rather than the leader of
the country that currently occupies the EU’s rotating presidency.
Charlemagne, The Economist 26 October 2014

ECB should abolish its OMT program – which, according to Germany’s Constitutional Court, does not comply with EU treaty law anyway.
Furthermore, the ECB should reintroduce the requirement that TARGET2 debts be repaid with gold, as occurred in the US before 1975

The fiscal compact – formally the Treaty on Stability, Coordination, and Governance in the Economic and Monetary Union
French Prime Minister Manuel Valls and his Italian counterpart, Matteo Renzi, have declared – or at least insinuated – that they will not comply with the fiscal compact to which all of the eurozone’s member countries agreed in 2012
Their stance highlights a fundamental flaw in the structure of the European Monetary Union – one that Europe’s leaders must recognize and address before it is too late.Hans-Werner Sinn, Project Syndicate 22 October 2014

Italy’s Downward SpiralItaly’s new prime minister, Matteo Renzi, wants to stimulate growth. But what he really intends to do is accumulate even more debt.
True, debt spurs demand; but this type of demand is artificial and short-lived. Sustainable growth can be achieved only if Italy’s economy regains its competitiveness,
and within the eurozone there is only one way to accomplish this: by reducing the prices of its goods relative to those of its eurozone competitors. What Italy managed in the past by devaluing the lira must now be emulated through so-called real depreciation.
Hans-Werner Sinn, Project Syndicate 21 August 2014

Renzi is not alone in this. On the contrary, virtually the entire European political elite, from Brussels to Paris to Berlin,
still believes that Europe is suffering from a mere financial and confidence crisis.
The underlying loss of competitiveness is not discussed, because that is a problem that discussion alone cannot resolve.

Hans-Werner Sinn, Professor of Economics and Public Finance at the University of Munich,
is President of the Ifo Institute for Economic Research and serves on the German economy ministry’s Advisory Council.
He is the author of Can Germany be Saved?

Italy’s PM Matteo Renzi wants the EU’s budgetary rules to be interpreted more loosely – so that money spent for ‘growth-enhancing’ purposes does not count as part of the budget deficit.
At a summit at the end of June, EU leaders agreed that they should make “best use” of the flexibility in the Stability and Growth Pact.
Crucially, however, the rules were to remain the same.Nevertheless Italian officials have been holding this up as a significant blow-to-austerity victory.
EU Observer 7 August 2014

Italy's Renzi must bring back the lira to end depression
Output has collapsed by 9.1pc from the peak, back to levels last seen 14 years ago. Industrial production is down to 1980 levels.
It takes spectacular policy errors to bring about such an outcome in a modern economy.
Ambrose Evans-Pritchard, 13 Aug 2014

I do not wish to revisit the stale debate over why Italy kept losing labour competitiveness against Germany for a decade and a half, except to say that it proves just how hard it is to bend Europe's deeply-rooted cultures to the demands of a currency experiment.

Economists said EMU nations would converge.
Anthropologists and historians said they would do no such thing.

However we got there, the situation is now untenable.
Italy is 30pc overvalued against Germany. It cannot claw this back by deflating since Germany itself is near deflation.
Italy must look after itself. It can recover only if it breaks free from the EMU trap, retakes control of its sovereign policy instruments and redominates its debts into lira, with capital controls until the dust settles.

Italy is the third largest economy in the eurozone,
one that has underperformed since the single currency was established 15 years ago,
and for a decade before that.
BBC 25 February 2014

If we go back to the turn of the century and look at the total growth achieved up to last year,
we find that both Germany and France have managed 15 %.
That yields an average of about 1% per year, which is not impressive.

Spain, even after the financial crisis in which it was one of the eurozone's casualties, is 18% ahead of where it was in 2000,
and Ireland is more than 30% up.
Italy's total growth in the same period is approximately nothing.

The argument between Italy and Germany asks a question at the heart of the currency’s futureCan an arrangement that will always fall well short of a textbook monetary union
be at once economically robust and politically sustainable?Philip Stephens, FT 10 July 2014

Matteo Renzi is rubbing shoulders with the likes of Barack Obama at G7 summits, and is emerging as the biggest counterweight to German Chancellor Angela Merkel on the EU political landscape.
John Mauldin 23 June 2014

His Democratic Party (PD) took 40.8 percent of votes – the best-ever result for the Italian left, and the highest score ever recorded by a single party since the Christian Democrats in 1958 – has given him a strong hand to challenge Berlin-backed austerity policies, as Italy takes on the EU’s six-month presidency on 1 July.

Tim Geithner recounts in his book Stress Test: Reflections on Financial Crises just how far the EU elites are willing to go to save the euro, even if it means toppling elected leaders and eviscerating Europe’s sovereign parliaments.
The former US Treasury Secretary says that EU officials approached him in the white heat of the EMU crisis in November 2011 with a plan to overthrow Silvio Berlusconi, Italy’s elected leader.
"They wanted us to refuse to back IMF loans to Italy as long as he refused to go," he writes.Ambrose Evans-Pritchard, May 15th, 2014

Wolfgang Münchau
Supporters of currency union have failed to explain how Italy can prosper inside a monetary union with Germany.The lazy argument is that Italy’s problems have nothing to do with the exchange rate regime. It is all about structural rigidities. As long as Italy reforms, all is well.
This is nonsense. Globalisation was an asymmetric shock.
It brought new customers for German luxury cars, but for Italy it mainly brought new competitors.It would not be unreasonable for a country to respond to an asymmetric shock through an exchange rate devaluation.

Italians have been suffering for much longer than other southern Europeans.

Electorates can be relied upon to reject systems that fail to produce economic growth for long periods.

Total bank assets in Italy stand at a relatively modest 2.6 times GDP, compared with 3.2 times in the whole of the euro area. Italian banks generally shunned the sorts of toxic financial instruments that brought down banks in America and Germany. And the country has not experienced a housing bust on a par with that in Ireland or Spain.

Yet for all their sobriety, Italian banks are struggling amid a mountain of bad debts from Italian businesses, big and small.

As the European Central Bank prepares to conduct stress tests and asset quality reviews of hundreds of banks across the eurozone, there is particular worry among some European regulators about Italy’s banks.

These concerns have led the Bank of Italy to conduct its own intensive examinations across the nation, such as the one at Banca Alberobello, ahead of the ECB tests. From Banca di Sicilia in the deep south to Banco di Trento e Bolzano, in the German-speaking northeast, the Bank of Italy is staging its toughest examination of the nation’s banks in history.
Financial Times, 4 March 2014

Italy’s new prime minister will have the most difficult job in Europe. Once confirmed, he will preside over a country with three fundamental economic problems:
it has very large debt; it has no growth; and it is a member of a poorly functioning monetary union.Wolfgang Münchau, FT, February 16, 2014

The plot is thickening fast in Italy.
Romano Prodi – Mr Euro himself – is calling for a Latin Front to rise up against Germany and force through a reflation policy before the whole experiment of monetary union spins out of control.
Ambrose Evans-Pritchard, November 4th, 2013

The so-called "Frenkel Cycle", the brutal denouement of every fixed-exchange rate system and every monetary union that fails to meet the four basic conditions"The debt-to-GDP ratio has risen by 15 percentage points [to 133pc] over the past 15 months because there is no growth.
It is all because of the effects of austerity and the fiscal multiiplier. We are making the same mistake they made in Greece."
Ambrose Evans-Pritchard, 30 Oct 2013

The report cited the so-called "Frenkel Cycle", the brutal denouement of every fixed-exchange rate system and every monetary union that fails to meet the four basic conditions of an optimal currency area.

These are labour mobility across borders, wage and price flexibility, fiscal transfers and aligned business cycles.

Italy, saddled with the euro region’s second-largest debt, is the “biggest threat” to the economy of the 16-member bloc, according to Nobel Prize-winning economist Robert Mundell.Bloomberg Feb. 17 2010

Brussels is demanding that Monte dei Paschi di Siena, the world's oldest bank, be subjected to tougher penaltiesbefore it approves the €3.9bn state bailout of Italy’s third-biggest bank by assets.
Financial Times, July 28, 2013

The European fiscal compact, an inter-governmental treaty that came into effect in January, provides far less flexibility to countries as they try to meet their deficit-cutting targets than they had under previous agreements.Under the fiscal compact, Italy will be required to pay back debt worth more than 2 per cent of GDP each year.To achieve that goal, Italy will need to run very large structural surpluses for almost a generation.
Wolfgang Münchau, Financial Times, May 5, 2013

Italy’s new premier Enrico Letta is on a collision course with Germany after vowing to end death by austerity,
and warned that Europe itself faces a “crisis of legitimacy” “Italy is dying from fiscal consolidation. Growth policies cannot wait any longer,” he told Italy’s parliament.
He said the country is in “very serious” crisis after a decade of stagnation and
warned of violent protest if the social malaise deepens.
Ambrose Evans-Pritchard 29 Apr 203

The grand coalition of Left and Right - the first since the late 1940s - will abolish the hated IMU tax on primary residences, a wealth levy imposed by ex-premier Mario Monti, and push for tax cuts for business and young people to pull the country out of perma-slump.

A rise in VAT to 22pc in July may be delayed.

Vice-premier Angelo Alfano - the appointee of ex-premier Silvio Berlusconi - said he agreed with every word from “beginning to end”,
as the Berlusconi camp claimed “total victory” over the policy agenda.

But while Mr Letta promised that Italy would abide by fiscal commitments made to Europe
he did not explain where the government would find the lost revenues of up to €6bn.

Mr Berlusconi took his party to the brink of victory in those elections with a fiercely anti-austerity message aimed against Germany’s “hegemony” in Europe. Italy’s recession and anger at the political elite also led to the populist Five Star Movement winning a quarter of votes in parliament where it is now the largest opposition force.

However Mr Letta stressed the pro-Europe orientation of the new government, saying it would push for
greater economic and political unity in a “United States of Europe”.

Too big to fail or to bailThis is dangerous. It is hard to see Italy remaining in the single currency in such dire straits
— and equally hard to imagine the euro surviving if it falls out.
Italy is the euro zone’s third-biggest economy and, although its budget deficit is quite small,
it has the biggest stock of public debt (at almost 130% of GDP). This makes it too big to bail out.
The Economist print 2 March 2013

The irony is that both of Italy’s clowns have got one thing right. Mr Grillo was right about Italy’s overpaid and corrupt politicians. Mr Berlusconi was right that austerity alone will not solve Europe’s crisis.

The turmoil produced by the Italian elections has directed attention back to where it should have been all along – to the politics of the eurozone crisis.
It is possible that southern Europe will give the Germans until the autumn to come around to a new approach.
But toleration for austerity is unlikely to last much beyond then.Europe may be approaching a stark choice: giving up the euro; or keeping it and seeing the political crisis spin out of control.
Mark Mazower, professor of history at Columbia university, Financial Times 28 February 2013

The great fear is that ECB will find it impossible to prop up the Italian bond market under its Outright Monetary Transactions (OMT) scheme
if there is no coalition in Rome willing or able to comply with the tough conditions imposed by the EU at Berlin’s behest.
Europe’s rescue strategy could start to unravel
Ambrose Evans-Pritchard 26 February 2013

Andrew Roberts, credit chief at RBS, said: “What has happened in these elections is of seismic importance.
“The ECB rescue depends on countries doing what they are told. That has now been torn asunder by domestic politics in Italy.
“The big risk is that markets will start to doubt the credibility of the ECB’s pledge.”

Mr Roberts said: “The big unknown is how much Germany is going to buckle over the next six months.

German leaders want to keep up the appearance that the eurozone crisis has been solved, at least until their elections in September.”

Italy Votes for Chaos and the Euro Crisis Is BackBloomberg, Megan Greene 26 February 2013

Italy’s parliamentary election could not have gone worse for the country or the euro area.

It is now possible that in the coming months the currency zone’s third-largest economy will need a bailout from international creditors,
at a time when Italy will have no government in place to ask for, or negotiate, a rescue.
In case you had any doubts, the euro-area crisis is back.

The German crisis-exit narrative has been so unbelievably complacent
– everyone pursuing austerity, then happiness forever – that these elections came as a total shock.

Angela Merkel did not say anything (quite wisely, we think).
Frankfurter Allgemeine quotes leading German economists and business representatives to devastating effect.
Lars Feld, a member of the German Council of Economic Advisers, predicted that investors will withdraw money from Italy, which will result in a rise in risk spreads. The Italian economy will then not be able to get out of recession. And that raises, once again, question about Italy’s debt sustainability.
The eurozone crisis will have returned with full force.

The head of Germany’s export association is quoted as saying that Germany should now contemplate the possibility of what he euphemistically called “a modified eurozone”.

(German exporters calling for a break-up of the eurozone is one degree more stupid than turkeys voting for Christmas. But we completely agree with Lars Feld on his description of the dynamics.)

If it can happen in Italy then why not in Greece, Spain, Portugal or France? The writing is emblazoned now clearly on the wall which declares
opposition to living under the dictums handed down from other countries
This is clearly defined by the total rejection of Monti and the Brussels/Berlin austerity measures that he put in place.
The vote for Monti at just under ten percent is a ringing condemnation of the European Union by the people of Italy.Tyler Durden/Mark J. Grant, Zerohedge 26 February 2013

This vote was not just a massive rejection of politics as it is played in Italy.
It was also a rejection of the policies championed by Mario Monti, the unelected prime minister who replaced Silvio Berlusconi.He was widely praised in Brussels for bringing stability to Italy but his austerity measures are blamed for deepening the recession.
He was a major loser in this campaign. Europe's leaders feted Mr Monti but the people did not. This vote was a rejection of the austerity being pursued by Brussels to save the single currency.Gavin Hewitt, BBC Europe editor, 26 February 2013

The extraordinary success of the protest movement of Beppe Grillo.
One in four voters backed a movement that has promised to shake up and kick out Italy's political establishment.Mr Grillo has tapped into a mood of anger and resentment. He never gave a single interview to Italian TV and yet has nearly 170 seats.

The country is in deep recession. Unemployment is rising and industrial production is at its lowest level since the 1990s.

Mr Grillo raged against corruption, against budget cuts, against austerity and promised to hold a referendum on continued membership of the euro.

Messy Italian Election Shakes World MarketsVoters delivered political gridlock that could once again rattle Europe's financial stability.The Dow Jones Industrial Average swung nearly 300 points, ending with its worst day in almost four months,
Wall Street Journal 25 February 2013

Italy
a general election in which voters delivered a resounding rebuff to austerity policies .
The upstart anti-establishment Five Star Movement, founded only three years ago by the comedian-blogger Beppe Grillo,
was on course to stage the biggest shock by garnering the largest number of votes of any single party.
the grassroots movement was leading on 25.5 per cent
But the nation was torn three ways between Mr Grillo and his band of political novices, Pier Luigi Bersani’s centre-left coalition and Silvio Berlusconi’s centre-right alliance,
raising the prospect of a second election within months.
Financial Times 26 February 2013

Perhaps the most important point to have emerged is that the crisis is subject to growing political risks.
The fall of the Dutch government and the victory of François Hollande in the first round of the French presidential election demonstrate this point. The street might overwhelm the establishment.Martin Wolf, Financial Times, April 24, 2012

Paul Krugman has got in early to comment on the political demise of Mario Monti
– who now seems certain to trail in fourth in the Italian elections.
According to Krugman, Monti’s reputation for wisdom is wildly overblown.On the contrary, he more or less deserves his fate because he was “in effect, the proconsul installed by Germany.”
Worse, according to Krugman, Monti’s policies did not even work.Gideon Rachman, Financial Times February 25 2013

As in the rest of southern Europe, the economy has shrunk and so debt-to-GDP ratios have risen. There was only one “piece of good news” in the Monti era – that “bond markets have calmed down.” However, Monti cannot claim the credit even for this, because it is “largely thanks to the stated willingness of the ECB to step in and buy government debt when necessary.”

As ever, with Krugman, the argument is forcefully made. But it misses out a crucial stage in the argument and therefore unfairly denigrates the role of Monti in stabilising the Italian economy.

Austerity, Italian Style
What good, exactly, has what currently passes for mature realism done in Italy or for that matter Europe as a whole?
For Mr. Monti was, in effect, the proconsul installed by Germany to enforce fiscal austerity on an already ailing economy;
willingness to pursue austerity without limit is what defines respectability in European policy circles.

For anyone with a sense of history,the sight of the German representative on the ECB being isolated and outvoted should be chilling.
Since 1945, the central idea of the European project was
never again to leave a powerful and aggrieved Germany isolated at the centre of Europe. Gideon Rachman, Financial Times, September 10, 2012

ECB has revealed that Italian government bonds make up nearly half of its holdings under a bond-buying plan
Italian bonds with a book value of 99bn euros account for the biggest holding under the now ended Securities Market Programme.BBC 21 February 2013

Silvio Berlusconi said Merkel’s East German roots had made her too rigid and too austerity-minded.Berlusconi says Merkel is an "intelligent bureaucrat" tied to the notion of a centralized economy.
He disagrees with the notion that the fiscal compact was designed to shore up the common currency.
He said the Fiscal Compact imposes a shoe size 42 for men and 40 for women.
This is why he says he wants to renegotiate the entire Compact if elected.
Eurointelligence 19 February 2013

The ECB's Mario Draghi has taken the risk of a sovereign default in Spain and Italy off the table,
but he has not restored these countries to economic viability within a D-Mark currency bloc, and nor can he.

Mario Monti's exit is only way to save ItalyThe nation is richer than Germany in per capita terms, with some €9 trillion of private wealth.
It has the biggest primary budget surplus in the G7 bloc.
Its combined public and private debt is 265pc of GDP, lower than in France, Holland, the UK, the US or Japan.
Italy has only one serious economic problem. It is in the wrong currency
Ambrose Evans-Pritchard, 10 Dec 2012

The one great obstacle is premier Mario Monti, installed at the head of a technocrat team in the November Putsch of 2011 by German Chancellor Angela Merkel and the European Central Bank – to the applause of Europe’s media and political class.

Mr Monti may be one of Europe’s great gentlemen but he is also a high priest of the EU Project and a key author of Italy’s euro membership. The sooner he goes, the sooner Italy can halt the slide into chronic depression.

Normal service is resuming.
After a year of relative stability and regained market confidence,
Italy is plunging back into political turmoil with the familiar sight of Silvio Berlusconi gearing up for yet another electoral campaign – his sixth in 19 years – against a centre-left still seeking to shed its proto-communist image.
Financial Times 9 December 2012

After all, it's not Spain that is responsible for 57% of the sovereign debt of the troubled eurozone economies - it's Italy.And come the spring, Italy will be looking for a new prime minister.
Stephanie Flanders, BBC Economics editor, 16 November 2012

In their punchy new book, Democrisis, David Roche and Bob McKee say Italy is the "circuit-breaker" that could make a lot of the crisis go away: "Italy represents more than half of every form of measurable economic contagion of the eurozone sovereign debt crisis... If the markets believe Italy is 'saveable', a virtuous outcome is possible and contagion will go into reverse."

That makes Italy sound very much like the pivot state: the country whose future could dictate everyone else's.

What happens if a large, high-income economy, burdened with high levels of debt and an overvalued, fixed exchange rate, attempts to lower the debt and regain competitiveness?
This question is of current relevance, since this is the challenge confronting Italy and Spain.
Yet, as a chapter in the International Monetary Fund’s latest World Economic Outlook demonstrates,
a relevant historical experience exists: that of the UK between the two world wars. Martin Wolf, Financial Times, 9 October 2012

Officials at the country’s central bank complained that the parameters in regulatory stress tests were unrealistically harsh on Italian banks.
They disputed the exact number of failures, after nine Italian lenders fell short in a comprehensive review unveiled by the European Central Bank.

The announcement represents the culmination of more than a year of intensive work costing hundreds of millions of euros and involving thousands of officials and accountants – all aimed at restoring investor faith in European banks ahead of the launch of a unified banking supervisor in Frankfurt.

The world's oldest surviving bank, Monte dei Paschi di Siena (MPS), has reported a bigger-than-expected loss.The Italian bank, which has been in business since 1472, reported a second quarter loss of 179m euros (£142m),
three times the loss analysts had been expecting. It was the bank's ninth consecutive quarterly loss
BBC 7 August 2014

n June, MPS raised 5bn euros on the stock market which it used to pay back state aid and boost its financial situation

Monte dei Paschi di Siena, Italy’s third-largest bank by assets, is set to launch a €3bn capital raising
in the second half of May after the banking foundation that is its controlling shareholder cleared a crucial obstacle to the deal.
FT 19 March 2014

Monte dei Paschi di Siena, the world's oldest bank, took five centuries to accumulate its wealth -- and three years to gamble it away.
Its fall from grace is a disaster for its home city of Siena, which relied on distributed profits from the bank.

Brussels is demanding that Monte dei Paschi di Siena, the world's oldest bank, be subjected to tougher penaltiesbefore it approves the €3.9bn state bailout of Italy’s third-biggest bank by assets.
Financial Times, July 28, 2013

The EU’s competition enforcer told Italy that the proposed restructuring plan for the 500-year-old lender is too soft on executive pay, cost-cutting and treatment of creditors, according to private correspondence seen by the Financial Times.

In a SPIEGEL interview published on Monday, Monti warned that European leaders could not allow themselves to be bound entirely to parliamentary resolutions in their efforts to save the euro.

"If governments let themselves be fully bound by the decisions of their parliaments without protecting their own freedom to act, a break up of Europe would be a more probable outcome than deeper integration," he warned in the SPIEGEL interview.

Moody's downgraded Italy's government bond rating two notches from A3 to Baa2. This is just above junk status.
Moreover, the outlook is negative with further downgrades possible in the near future. So what happened in the Italian government bond auction this morning? Did buyers demand higher interest rates?
No they didn't. How is this possible?
Apparently Italian banks couldn't resist an urge to grossly overpay for their government's newly issued debt. The ECB was most certainly backing them up behind the scenes.
Seeking Alpha 13 July 2012

If this is how Italian banks do business, can we assume that they're solvent?

There is little need to pose that question for Spanish banks. Recent data indicate that they borrowed €365 billion in June from the ECB - a record amount.

Mario Monti and the Limits of Technocracy
When Mario Monti was appointed - not elected - prime minister in November,with the economy headed for collapse, technocratic leadership and a break from politics as usual were exactly what they wanted.
So they thought.
Now, opinion polls put Monti’s approval rating at slightly more than 30 percent, down from more than 70 percent at the start of his tenure.
Editors, Bloomberg 27 June 2012

There’s only so much a technocratic leadership can achieve. In a democracy, a sustained effort at institutional and economic reform -- changes that make powerful interests worse off even as they advance overall living standards -- must be underwritten by voters. Politicians must put forward the case for painful measures and win a mandate to make them happen.

In a broken political system, which Italy’s is, the rule of technocrats can serve a vital temporary purpose. We applaud what Monti has done. But as Italy’s economic crisis escalates once again, its leaders can no longer put politics aside. That’s both understandable and inevitable, if not all that encouraging.

Yet even continued gifts under some sort of fiscal union would not bring prosperity, as we see clearly in Italy. Italian unification in 1861 married the Germanic north with the Latin south. The consequent misalignment continues to this day.
If the euro holds together, this would leave the southern peripheral countries as a giant version of the Mezzogiorno.Roger Bootle, Telegraph 24 June 2012

Desperate Monti needs Merkel summit deal to stop revolt at home
Italy's technocrat government risks a parliamentary mutiny unless premier Mario Monti can secure major concessions from Germany
at a crucial summit of the eurozone's Big Four powers in Rome on Friday.
Ambrose, 21 June 2012

The main Left and Right parties have until now backed Mr Monti's fiscal squeeze – a net tightening of 3.2pc of GDP this year – and radical reform of pension and labour markets.

The implicit trade-off was that Brussels and the European Central Bank would in return intervene to keep the bond vigilantes at bay, if necessary. Germany has so far blocked such action. Yield spreads of 10-year Italian bonds over German Bunds neared a record 500 basis points last week.

The soft-spoken Professor Monti – flanked by French president Francois Hollande and Spanish premier Mariano Rajoy – is unlikely to be so blunt. Yet he has lured German Chancellor Angela Merkel into a Latin ambush, symbolically staged in the seat of Roman power.

The unspoken message is that Germany does not command a majority vote at Europe's high table and can no longer rely on the Franco-German axis to impose its will. The deal agreed by the quartet in Rome – if there is one – will largely dictate the final EU response to the crisis next week in Brussels.

Berlusconi says Italy should quit eurozone unless Merkel changes course
Ok, he is no longer Italy’s prime minister, but he is still the leader of one of Italy’s most important political parties.
Eurointelligence Daily Briefing 21.06.2012

He said the eurozone crisis can have one of three outcomes.
Either Germany allows the ECB to backstop everything.
Second, Germany leaves.
Third Italy leaves.

Number is two is not going to happen, so we are left with the bifurcation we have forecasting for a long time.

Either they agree a full backstop – which can logically only come from the ECB, and which in turn requires a political union – or the eurozone collapses.

Corriere also has a reference to an interview of Berlusconi in the Wall Street Journal in which he clarified his position further. He said the departure of the a country from the eurozone, or even the collapse of the eurozone, were not subject to polite conversation in Europe until recently, but they are now possible. Here is a section from the excerpt of the interview:

“I see three possible outcomes. The first is that Germany is persuaded and therefore the ECB becomes a backstop for the euro. The second possibility is that Germany leaves the euro…The third solution is that Italy leaves the euro and we reintroduce our own currency, which would bring many advantages.”

And then he went on the attack against Angela Merkel:

“If we continue on with the policies of Signora [Angela] Merkel [the German chancellor], who before had the backing of Sarkozy, demanding that countries reduce their public debt, we'll end up in a worsening recessionary spiral. This is really the wrong policy.”

(Discussing a euro exit is still considered blasphemy by centrist European parties, especially in Italy. So this is an important statement, as he is still an influential political leader. It is also a sign that the anti-euro campaign by Beppe Grillo is having an effect.)

The vicious euro circle keeps turning
Why are investors still so gloomy about Spain?
Stephanie Flanders, BBc 12 June 2012

The core of the problem for Spain - reflected very clearly in the market movements of the past few days - is economic growth. In Italy, too - worries about the state of the economy helped push up the Italian government's cost of borrowing at the start of the week.

The world is uncomfortably close to a 1931 momentItaly must guarantee 22pc of the bail-out funds, even though it cannot raise money itself at a sustainable rate.
You could hardly design a surer way to pull Italy into the fire.Ambrose Evans-Pritchard, 10 Jun 2012

The Spanish 10-year bond yield hit 6.81 %, as optimism about the weekend's Spanish bank bailout continued to evaporate.
Italy's 10-year bond yield rose to 6.28 %, a rate not seen since January, as concerns about its finances rose.
BBC 13 June 2012

The interest rates are seen as unsustainable in the long run for two countries weighed down by huge debts.

Also stressed to virtual breaking point,
Italy, becomes liable for some 17.9pc of the cross guarantees, raising the absurd spectacle of Italy borrowing at 5pc to lend to the Spanish banking system at 3pc.
European solidarity may be a noble cause, but there must be limits.
Jeremy Warner, Telegraph 11 Jun 2012

Italian Prime Minister Mario Monti also got into the act on Thursday by demanding that the euro backstop fund, the European Stability Mechanism (ESM),
be allowed to provide fresh capital directly to struggling European banks,
a move that Germany has strictly opposed thus far.
Der Spiegel 1 June 2012

In a video-taped presentation for a conference in Brussels, Monti challenged Berlin to "think deeply yet quickly" about further instruments to combat the crisis facing Europe's currency. The focus of such cogitation, he said, should be the Continent's banks.

As Greece erupts, Italy is moving into the eye of the storm.
Its economy is contracting at speeds not seen since the depths of the slump in 2009
as draconian austerity bites, greatly increasing the risk of social revolt and a banking crisis
Ambrose Evans-Pritchard, 15 May 2012

With the world's third largest debt after the US and Japan at €1.9 trillion (£1.18 trillion), it is big enough to bring the global financial system to its knees.

It is also in the front line of contagion as the Greek crisis metastasizes.

Spanish and Italian banks are trapped with large losses on sovereign bonds bought with ECB funds (LTRO).
Spanish banks used ECB funds to purchase five-year Spanish bonds at yields near 3.5pc in February and 4.5pc in December.
The same bonds were trading at 4.77pc on Wednesday, implying a large loss on the capital value of the bonds.It is much the same story for Italian banks pressured into buying Italian debt by their own government.
Any further dent to confidence in Italy and Spain over coming weeks could push losses to levels that trigger margin calls on collateral.Ambrose Evans-Pritchard 11 April 2012

From November to February, during which the central bank lent more than 1 trillion euros to 800 European banks, Spanish banks increased their holdings of government securities by 68 billion euros and
Italian banks by 54 billion euros New York Times 9 April 2012

Yes, Mussolini pulled off a 20pc cut in wages in the late 1920s.
How can a democracy bring about such cuts in private sector wages without use of police coercion? Portugal, Italy, and Spain need an "internal devaluation" of around 20pc
to claw back competitiveness within EMU. This means draconian wage cuts for year after year.Ambrose Evans-Pritchard, 5 April 2012

The Germans entered EMU at an overvalued rate
after the Reunification bubble, leaving them in semi-slump for half a decade.They slowly clawed back competitiveness the hard way, by squeezing wages and driving up productivity.
It is entirely understandable that they now think Club Med can and should do the same.
They are profoundly wrong, of course, because Germany was able to lower relative wages during
a) a global boom, b) against other EMU states that were inflating c) and with benchmark borrowing cost that stayed low even during the dog days. None of these factors apply to Italy or Spain now.Ambrose Evans-Pritchard, December 2nd, 2011

Nouriel Roubini: markets are “schizophrenic” they cannot decide whether to reward or punish countries such as Spain and Italy for their austerity plans. “Without growth, the socio-political backlash will become overwhelming for some governments.”
The euro needs to sink to parity with the US dollar in order to restore Europe’s peripheral economies to growthCNBC 30 March 2012

Monti called the breaches of the Maastricht Treaty limits on deficit ceilings by France and Germany, soon after the launch of the single currency, the "worst mistake in the EU in the past ten years".CNBC 11 Jan 2012

Germany has long insisted that austerity be the primary strategy used in confronting the ongoing euro-zone debt crisis. Italy has now joined France in demanding a more nuanced approach.
Italian prime minister seems to have lost his enthusiasm for austerity. He has begun pursuing a different direction - one diametrically opposed to that which German Chancellor Angela Merkel would like to see.Der Spiegel, 11 January 2012

Italy paid a euro era record yield of 6.47 percent
to sell five-year paper at its first auction of longer-term debt
after the EU moved towards greater fiscal integration at last week's summit
CNBC 14 Dec 2011

In Italy, Chancellor Merkel is seen as having helped engineer, along with the European Central Bank, Silvio Berlusconi's departure.

Mario Monti's weakness is that he is seen as "sponsored" by Berlin and Brussels.
All the time spent discussing his plans with European officials undermines his standing at home.
As an unelected leader he will have to implement deeply unpopular cuts without a mandate.
Rightly or wrongly some of the anger will attach itself to Germany.
Gavin Hewitt, BB Europe editor, 30 November 2011

It did not help that almost as soon as he was elected in Spain, Mariano Rajoy was on the phone to Berlin.

Everything depends on Italy, because financial markets now fear that it may be insolvent.
Italy can save both its own economic sovereignty and the euro if it acts decisively and quickly to convince the financial markets
that it will balance its budget and increase its rate of economic growth so that the ratio of its public debt to its gross domestic product will decline in a steady and predictable way.
Martin Feldstein, Financial Times, 30 November 2011

If the Italian government has to continue paying a seven or even eight per cent interest rate to finance its debt, the country’s total debt will grow faster than its annual output and therefore faster than its ability to service that debt.

If investors expect that to persist, they will stop lending to Italy. At that point, it will be forced to leave the euro. And if it does, the value of the “new lira” will reduce the price of Italian goods in general and Italian exports in particular.

The resulting competitive pressure could then force France to leave the euro as well, bringing the monetary union to an end.

But this need not happen. Italy can save both its own economic sovereignty and the euro if it acts decisively and quickly to convince the financial markets that it will balance its budget and increase its rate of economic growth so that the ratio of its public debt to its gross domestic product will decline in a steady and predictable way.

7.89 % for three years, and 7.56 % for 10 years
The make-or-break question - for Italy and for the eurozone - is whether there is the faintest chance those rates will fall, without the supply of emergency finance to a highly indebted government that's presiding over a very slow-growing economy.
Robert Peston, BBC Business editor, 29 November 2011

The precedent of Greece, Portugal and Ireland suggests there is little prospect of Italy's borrowing costs returning to non-penal levels without outside help, even if its government of technocrats produces a credible programme both to reduce the mountain of debt and put some fuel in the economy.

If Germany genuinely wishes to save Spain and Italy, it must allow EMU-wide reflation and mobilize the ECB as a lender of last resort to halt the bond crisis, since the EFSF rescue fund does not exist.
To create a currency without such a backstop is criminally irresponsible. Ambrose Evans-Pritchard, DT, 20 Nov 2011

Italy’s labour cost competitiveness against Germany has deteriorated by around 50 per cent since the mid-1990s. How can this conceivably be reversed in a low inflation environment within EMU?
Gavyn Davies, FT November 13, 2011

Many of the most essential labour market reforms will certainly add to unemployment and
deepen the recession in the short run, making the budget problem even more difficult.

With interest rates on its sovereign debt surging well above seven per cent, there is a rising risk that Italy may soon lose market access.
Given that it is too-big-to-fail but also too-big-to-save, this could lead to a forced restructuring of its public debt of €1,900bn.
That would partially address its “stock” problem of large and unsustainable debt but it would not resolve its “flow” problem,
a large current account deficit, lack of external competitiveness and a worsening plunge in gross domestic product and economic activity.
Nouriel Roubini, FT 10 November 2011

To resolve the latter, Italy may, like other periphery countries, need to exit the monetary union and go back to a national currency, thus triggering an effective break-up of the eurozone.

Eurobonds are out of the question as Germany is against them and they would require a change in treaties that would take years to approve.

Last week, everyone was insisting that the departure of Prime Minister Silvio Berlusconi would calm markets. On Wednesday, it became apparent that the opposite was true.
After all, what comes next might be worse.
Der Spiegel 9 november 2011

People are worried about Italy's future because they suddenly remember its past. Between the end of World War II and 1994, when Berlusconi was first elected as prime minister, Italy had almost five dozen governments, few of which survived much longer than a year and many much shorter than that. Political chaos was long an Italian trademark before Il Cavaliere was able to impose some order.

The currency bloc is not so much suffering a sovereign-debt or banking crisis as a crisis of governance. How one views this governance crisis will depend partly on where one lives.

To a Northern European, the problem lies in the failure of some member states to control their borrowing or reform their economies to enable them to compete and grow under a single currency.

To anyone in the periphery or living outside the euro zone, the problem lies in the design of the euro,
which has left one of the richest region's in the world unable to prevent a debt crisis in one of its smallest economies
spiraling out of control and threatening to devastate the global economy.
Simon Nixon, WSJ, 8 Nov 2011

What the ECB is being asked to do is provide an open-ended commitment to subsidize Italy's debts by agreeing to underwrite the risk of default. That is a major transfer of fiscal sovereignty that will de facto make all euro-zone countries henceforth responsible for each other's debts.
Even if the ECB had the legal power to assume this responsibility under the European treaties, which it says it doesn't,
it has no means to ensure countries stick to reform programs and thus minimize the risk of losses for taxpayers.

Ialy's debt crisis spiraling out of control. Italian government 10-year bond yields have reached a euro-era record of 6.7% — a level from which no other peripheral euro-zone country's bond market has recovered.
Increased European Central Bank bond-buying — last week's purchases were double those of the week before — have failed to halt the slide in prices.
European banks are dumping Italian bonds at a loss and being rewarded by the market.
Given the lack of adequate bailout facilities, many now argue that only an unequivocal commitment from the
ECB to act as a lender of last resort by signaling its willingness to buy unlimited quantities of debt
Simon Nixon, WSJ, 8 Nov 2011

What's more, the ECB's exposure to Italy isn't limited to bonds. It also is providing substantial lender-of-last-resort funding to its banks. When the ECB's total exposure to Greece, Ireland and Portugal grew to a significant proportion of their GDP, it rightly forced them to seek an alternative source of external financing.

Whatever Silvio Berlusconi's faults, which are undoubtedly many, since when was it thought acceptable for the central bank to effectively decide on what the government in Italy should be?
The now repeated imposition of supra-national policy by an unelected elite on the citizens of the eurozone has got to be ultimately unusustainable.
The dangers of extremist popularism followed in short order by Balkanisation are all too obvious.
Jeremy Warner, DT, November 8th, 2011

Far from promoting growth and political solidarity, which is what the single currency was supposed to do, the euro is in fact achieving the opposite effect, by condemning the eurozone to long term recession and now extreme political infighting

Unless the European Central Bank step in very soon and on a massive scale to shore up Italy, the game is up.
We will have a spectacular smash-up.
Italy is not fundamentally insolvent. It is only in these straits because it does not have a lender of last resort, a sovereign central bank, or a sovereign currency.
The euro structure itself has turned a solvent state into an insolvent state. It is reverse alchemy.
Ambrose Evans-Pritchard, 1 November 2011

If handled badly, the disorderly insolvency of the world’s third largest debtor with €1.9 trillion in public debt and nearer €3.5 trillion in total debt would be a much greater event than the fall of Credit Anstalt in 1931.

The Anstalt debacle triggered the European banking collapse, set off tremors in London and New York, and turned recession into depression. Within four months the global financial order had essentially disintegrated.

The referendum is a healthy reminder that Europe is a collection of sovereign democracies, tied by treaty law for certain arrangements. It is a union only in name.

Certain architects of EMU calculated that the single currency would itself become the catalyst for a quantum leap in integration that could not be achieved otherwise.

The sovereign nation of Germany has blocked every move to fiscal union, whether Eurobonds, debt-pooling, fiscal transfers, or shared budgets. It has blocked use of the ECB as a genuine central bank. The great Verfassungsgericht has more or less declared the outcome desired by those early EMU conspirators to be illegal and off limits.

In many ways, the euro-zone debt crisis is now all about Italy.
The Economist, Charlemagne 24 Oct 2011 with nice pic

In discussions all weekend, including at two European summits, leaders worked on drawing up a package deal to save the euro that should be concluded in another round of summits on Wednesday.

All three of the main issues – the fate of Greece, the “firewall" to prevent contagion and the recapitalisation of Europe' banks - revolved in some ways around Italy: if Greece's debt is restructured, will the markets then turn on Italy, the next most-indebted state in the euro zone? If so, is the new firewall big enough to protect Italy? And does the plan to strengthen banks with fresh capital, so that they can withstand the loss of value of their bond holdings, not place an unfair burden on Italy, whose banks hold vast amounts of depreciated Italian debt?

Angela Merkel of Germany and Nicolas Sarkozy of France thought differently. When asked whether Italy's prime minister had reassured them about doing his homework to draw up a plan to bring down Italy's vast debt and implement structural reforms, Mrs Merkel and Mr Sarkozy first hesitated, then looked at each other and, finally, smirked knowingly. (video clip here, in French)

According to Germany's chancellor, Angela Merkel,
"Italy has great economic strength, but Italy does also have a very high level of debt
and that has to be reduced in a credible way in the years ahead."However, some economists might disagree with her assessment.
BBC 24 October 2011

The big fear is "contagion" - that a Greek default could trigger a financial catastrophe for other, much bigger economies. And Italy seems to have ousted Spain as the lead candidate for that contagion. Why is that?

As with Greece, she and other eurozone leaders believe the solution is more government austerity - spending cuts and tax rises - by Rome.

The Italian government's debt, at 118% of GDP (annual economic output) is certainly high, even by European standards.

But dig a little deeper, and the picture changes.

Unlike their counterparts in Spain or the Irish Republic, ordinary Italians have not run up huge mortgages, and generally have very little debt.

That means that according to the Bank of International Settlements Italy as a country - not just a government - is not actually terribly indebted compared with other big economies such as France, Canada or the UK.

Moreover, the large debts of the Italian government are nothing new. It has got by just fine with a debt ratio over 100% of its GDP ever since 1991.

The main reason is because - unlike Greece - Italy is actually quite financially prudent.

The government spends less on providing public services and benefits to its people than it earns in taxes, and has been doing so every year since 1992, except for the recession year of 2009.

Europe’s crisis is all about the north-south split
Anticipating the euro, drachma-denominated 10-year sovereign bonds fell more than 450 basis points
relative to German Bund rates in the three years leading up to Greece’s adoption of the euro in 2001. Likewise, Portugal and ItalyAlan Greenspan, FT October 6, 2011

The Italian government yesterday raised €7,86bn at an interest rate of 5.86 %,
up from 5.22 % in August, according to Reuters.That level is inconsistent with Italy’s continued membership in the eurozone.
Eurointelligence 30 Sept 2011

Once the crisis hit Italy, followed by an absolutely inadequate policy response of the Italian government, the crisis has reached a point of No return.
Italy is too big to save with the current set of instruments, including ECB bond purchases, and in the absence of a credible programme of eurobonds,
he concludes that a breakup of the eurozone must now be considered as a probable scenario. The question is now whether and how the EU can survive such a cataclysmic event. Wolfgang Münchau in his column in FT Deutschland, ref. by Eurointelligence 21 September 2011

Italian bond spreads surpass 400bp for the first time in this crisis
The bond spreads rose after investors concluded that China is, after all, not going to bail out Italy
Eourointelligence 14 September 2011

There is nothing magical about apparent threshold numbers, but a spreads of 400bp is awe-inspiring because it clearly signals a lack of sustainability.

The greatest fear is that one of the Continent’s major banks may fail, setting off a financial panic like the one sparked by Lehman’s bankruptcy in September 2008.European policy makers, determined to avoid such a catastrophe,
are prepared to use hundreds of billions of euros of bailout money to prevent any major bank from failing. New York Times, 7 september 2011

Hans Werner Sinn, chef för det ansedda IFO-institutet
Euro bonds would destroy the euro zone. In 1995, shortly before the exchange rates for the euro were fixed,
the interest rates on Italian and Spanish debt were on average about 5 percentage points above Germany's.Der Spiegel 23 Augusti 2011

Italy alone has to raise or roll-over €68bn by the end of September.
You can be sure that a great number of investors will take advantage of ECB intervention between now and then to lighten their holdings, and switch the risk to eurozone taxpayers.
The ECB may have to buy at least €100bn of Italian bonds alone by late September to cap the 10-year yield at 5pc.Ambrose Evans-Pritchard, August 17th, 2011

The European Central Bank spent €22bn on government bonds last week
Some analysts have worried that because of the size of Italy’s and Spain’s bond markets
– totalling €2,100bn - the ECB could have difficulties in sterilising all its purchases
if it has to carry on buying on such a large scaleFT 16 august 2011

Italian Finance Minister compared Germany and its small-minded Chancellor to a first-class passenger on the Titanic. When the ship hits the iceberg, everybody goes down togetherRolf Englund blog 20 juli 2011

Italian public debt has been an accident waiting to happen
This is not because recent budgetary policy has been irresponsible.
Instead, it is because Italy has become trapped by two intractable problems – a high public debt ratio of around 120 per cent of GDP; and a chronically weak rate of GDP growth,
due to its increasingly uncompetitive production sector.
Gavyn Davies, FT blog 17 July 2011

Italian real GDP growth since the nation joined the euro has averaged only 0.6 per cent per annum, and it shows no signs of improving.

A very high debt ratio, together with low real GDP growth and a low inflation rate set by the ECB, is potentially a toxic mix.

A question (to which I don’t have the full answer): Why are the interest rates on Italian and Japanese debt so different?
As of right now, 10-year Japanese bonds are yielding 1.09 %; 10-year Italian bonds 5.76 %
Paul Krugman, July 16, 2011

Not so tender trapIn extreme circumstances, a country can get into a “debt trap”, in which the interest rate on its borrowings exceeds the growth rate of the economy.
Britain has the benefit, unlike Italy, of being outside the euro and
therefore is not locked into an inflexible monetary policy.
The Times editorial 12 July 2011

A spokesman for Herman Van Rompuy, president of the European Council, denied that senior officials would discuss the state of Italy’s finances
But another official, who requested anonymity because he was not authorized to speak publicly, said Italy would probably be on the agenda
New York Times 11 July 2011

For Italy, the cost of financing its debt rose at the end of the week, though nowhere near the levels faced by Greece. The spread between the yield on the Italian 10-year bond and the German equivalent widened on Friday to 2.36 percentage points, the most since the introduction of the euro.

The cost of insuring Italian debt rose sharply after the country’s trusted Finance Minister became linked to a corruption scandal There would be huge repercussions if Italy was badly affected because its economy makes up 16.7 per cent of eurozone GDP, compared with 2.4 per cent by Greece and 1.8 per cent by Portugal.
The Times 9 July 2011

Rome is expected on Thursday to approve an austerity drive worth up to 68 bn dollar in savings by 2014,
in a move aimed at reassuring the markets and its European partners on its fiscal discipline.
Financial Times 29 juni 2011

2 triljoner eurosYields on 10-year Italian bonds jumped 21 points to 4.61pc, threatening to shift the crisis to a new level. Italy's public debt is over €2 trillion, the world's third-largest after the US and Japan.
Ambrose Evans-Pritchard, 29 Nov 2010

"The EU rescue fund cannot handle Spain, let alone Italy," said Charles Dumas, from Lombard Street Research. "We we may be nearing the point where Germany has to decide whether it is willing take on a burden six times the size of East Germany, or let some countries go."

Italy could fall into a so-called 'debt trap.'
We think that it might take a decade or more of stagnant or falling wages to restore full competitiveness
Roger Bootle and his team over at Capital Economics
CNBC 6 Jul 2010

The only chance of Italy getting its debt-to-GDP ratio below 100 percent would be for it to run a budget surplus of 5 percent over 15 years.

“If doubts grow over whether the Government is willing or able to do this, Italy could fall into a so-called 'debt trap.'

Under this scenario, rising borrowing costs lead the debt-to-GDP ratio to increase at an accelerating rate, leaving the Government with no choice but to default.”

“If the Government were to default on its debts and investors were forced to take a large haircut of say 50 percent, this would wipe out around 80 percent of Italian banks’ tier one capital at a stroke, causing domestic financial market meltdown,"

I saw a bubble blowing up in housing a few years ago but I seriously underestimated how much longer it would inflate. I therefore gave my warnings of the market's demise too early.Roger Bootle 18 July 2008

Italy's outstanding public debt is €1.7 trillion, seven times the size of Greece's.
Italy "is a big systemic piece," said François Chauchat, an economist with GaveKal, a Stockholm-based economic advisory firm. "If Italy cannot refinance its debt than it's the end of the euro."
WSJ 14 May 2010

So far, markets have deemed Italy less risky than other Southern European nations despite a public debt equivalent to 115% of gross domestic product—about the same as Greece

"If the interest you're paying on debt is higher than the rate of growth, you end up in a death trap, where you're adding to the debt all the time," says Gabriel Stein, an economist with Lombard Street Research, a London-based economic advisory firm. "I don't know if Italy is in a death trap right now."

Italy, saddled with the euro region’s second-largest debt, is the “biggest threat” to the economy of the 16-member bloc, according to Nobel Prize-winning economist Robert Mundell.Bloomberg Feb. 17 2010

Millions of migrants have arrived in Greece, Italy and Spain over the past decade. To avoid serious social problems, those countries need to do a better job of making them feel welcomeTime Magazine March 1st 2010

The crushing defeat of the centre-left government and the complete ousting from parliament of its Communist wing, for the first time in 60 years,
was matched by a dramatic revival in the fortunes of the Northern League and Umberto Bossi, its leader.
Financial Times 18/4 2008

Silvio Berlusconi, the billionaire businessman, back in power at the age of 71, becomes prime minister for a third time but his newly named People of Freedom party maintains its majority only as long as Mr Bossi, 66, remains loyal to their coalition.

One serious open question if whether the countries – Italy, Portugal, Spain, Greece - that have experienced a significant loss of competitiveness and real exchange rate misalignment will be able implement reforms that will increase productivity growth, reduce relative unit labor costs and allow them to regain their lost competitiveness.Nouriel Roubini, New York University and RGE Monitor, 28/6 2007

Italy’s debt was downgraded on Thursday by two of the world’s leading credit ratings agencies
in a damaging blow to the centre-left coalition government of Romano Prodi, prime minister.
Financial Times 19/10 2006 ..... full text here

The agreements that established the euro contain no provisions to allow exit. However, if some government – let us suppose the Italian one – decided to leave, there is nothing Europe could or would do to stop it.
But what exactly would a government set on such a course – or forced into it – do?
John Kay, FT, 12/9 2006

Some people will conclude that these problems make a break-up of the euro impossible. This would be a profound error. History – not least the establishment of European monetary union itself – shows that, given political determination, practical problems will be overcome. Civil servants, lawyers and bankers are there to ensure that a client’s wishes are met even if misconceived and if the Bank of Italy does not have a plan in its safe, its officers have been failing in their plain duty.

The Italian election result was a disaster for Italy and is a threat to the future of the euro.
Italy is now in the economic condition that normally preceded devaluation of the lira in the years before the single currency. So long as Italy remains in the euro system it will be impossible to devalue, yet it would be equally impossible for a weak left-of-centre coalition, with no real majority, to take the tough economic decisions that might, or might not, restabilise the economy.
William Rees-Mogg, The Times, 17/4 2006

When the euro was first planned many critics argued that a single currency could survive only if it was backed by a single European government. Inside the euro system different national economies would develop separately and would diverge over time. Each economy would have to adjust to unforeseen external shocks, such as the increase in the oil price or in Asian export competition, but the shocks would have different impacts on different countries.

With no recourse to devaluation, countries would have to take painful economic decisions that might prove to be politically impossible; we have recently seen that in France

The structural weakness of the euro is that it is a single currency that has 12 different economies, 12 different electorates, 12 different governments, 12 different budgets and 12 different systems of sovereign debt. In the debt market itself there are 12 different values for the euro.

If Italy had to leave the euro the consequences would be quite sensational.

The euro itself would be expected to survive, but confidence would have been damaged. If Italy had to leave, who else might go in the future? One can expect every effort to prevent Italy leaving, both in Italy and in the rest of Europe. Even the US Federal Reserve would be worried. All uncertainty is bad for financial markets. If Italy leaves, it will be only after a lot more pain.

The narrow election victory by Romano Prodi’s centre-left alliance was the worst imaginable outcome in terms of Italy’s chances to remain in the eurozone beyond 2015.
Wolfgang Munchau, Financial Times 17/4 2006

These are not bets on Mr Prodi’s political commitment to the euro. It would be difficult to find a more pro-European politician than the former president of the European Commission.

These are bets on economic circumstances that might force a government to take decisions that are unthinkable until the moment they become inevitable.

If Italy continues to lose macroeconomic competitiveness, a populist political movement could well emerge with an agenda for euro withdrawal. Let us think the unthinkable and assume some future Italian government brings back the lira. What would then happen to the country’s mostly euro-denominated debt, which now stands at 106.5 per cent of gross domestic product? Italy would almost certainly be unable to service its obligations to investors in full. It would either convert those debts back into lira at an exchange rate unfavourable to investors or it would default outright.

Three factors may explain the markets’ optimism. First is the view that Italy may be effectively trapped inside the eurozone; leaving it would not solve any economic problems. This argument ignores the fact that default is usually not a consequence of rational choice but of panic. Second is the belief that the European Central Bank would ultimately bail out a defaulting member state. This view may underestimate the ECB’s resolve to observe its no-bail-out rule.

Third, even if one accepts the worst-case scenario, it is still highly unlikely that default would occur within the lifetime of a 10-year bond. This argument offers the most plausible explanation for why the markets have not placed a higher risk premium on Italian bonds. It is also explains why bond markets are notoriously poor early indicators of default risk. Bond investors are complacent until they start to panic.

Financial markets cannot force a country out of a monetary union through currency speculation – as they forced Britain out of Europe’s exchange rate mechanism in 1992. But there are other ways for investors to exploit a country’s difficulties in a monetary union. This is why there are parallels between Italy today and the UK in 1992.

Britain’s political commitment to the ERM appeared as unshakable then as Mr Prodi’s support for the euro looks now. But Britain was neither politically nor economically ready to live under a regime of semi-fixed exchange rates. Italy’s membership of the euro is based on similarly shaky foundations. Fourteen years ago, it took investors a few days to expose a political lie.

Italy’s seven years within the eurozone seem consistent with Dante’s famous inscription at the entrance of hell: “Abandon all hope, ye that enter”.The economic consequences of monetary union have been so serious for the country that they require urgent political action by the next Italian government. Without it there will be no escape from the inferno.
Wolfgang Munchau,Financial Times 20/3 2006

A 16 per cent appreciation of the real exchange rate over the last seven years has led to a loss of competitiveness and falling economic growth. If the trend of the last seven years were to persist for the next seven, the consequences for Italian industry and the solvency of the state would be near-catastrophic.

A constellation that might deliver some of these reforms would be a German-style grand coalition. By this, I mean not the present grand coalition in Berlin but the one that governed between 1966 and 1969. The sole rationale of that coalition was to implement economic reforms that were inconceivable under any other political constellation. Italy faces a similar political situation today.

Italy follows Argentina down road to ruin
Desmond Lachman, American Enterprise Institute (Timbros storebror)
Financial Times 17/3 2006
Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the IMF's Policy and Review Department and was active in staff formulation of IMF policies toward emerging markets.

An irony of Italy’s unfolding political and economic drama is that many of the current holders of the country’s bloated and ever-increasing government debt were once proud holders of Argentina’s now-defaulted sovereign bonds. As Mario Draghi, Italy’s new central bank governor, warns that the Italian economy has “run aground”, and as prime minister Silvio Berlusconi vents about “the euro having been a disaster for Italy” in the run-up to next month’s election, one has to wonder at what stage Italy’s bondholders will get the feeling that they have been to this sad movie before.

For quite aside from Italy’s disturbing political and institutional weaknesses ... the country’s economic predicament is remarkably similar to that of Argentina in the late 1990s.

The most striking similarity between the two countries is the rigid currency arrangements in which they locked themselves. As a reaction to its mid-1980s experience with hyperinflation, Argentina in 1991 nailed its currency to the convertibility plan cross. It did so in the hope of forcing on the country the low inflation and fiscal policy discipline that it had never before enjoyed.

In a similar effort to impose macro-economic discipline, Italy abandoned the lira for the euro in 1999. It was hoped that high inflation and periodic lira devaluations would give way to fiscal discipline and structural reform. By abandoning its currency, Italy, like Argentina before it, gave up macroeconomic policy flexibility to stabilise its economy. Italy can no longer engage in periodic exchange rate devaluations to rectify losses in international competitiveness. And no longer having its own monetary policy, it has to accept the interest rates set by the European Central Bank even though these might not necessarily conform to Italy’s circumstances. When Jean-Claude Trichet, the ECB president, recently tightened European monetary policy because of high oil prices, did he give much weight to Italy’s cyclical weakness?

If this is not bad enough, under Europe’s fiscal stability pact, Italy is committed to strengthening its public finances at a time of cyclical weakness.

On Friday I was in Davos in a panel on the "Ups and Downs of EMU" (European Monetary Union) where ECB head Trichet, Italian Economy Minister Tremont, a few other EU officials and myself were supposed to discuss the following questions:Will EMU collapse in the future? Which country will exit first? What will be the consequences of a break-up of EMU? How to avoid that? And what are the prospects for the Growth and Stability Pact?Nouriel Roubini, 28/1 2006

Will EMU survive 2010?
Global interest rates are likely to return to more normal levels. The ‘one size fits all’ policy of the ECB is then likely to become very difficult to bear for countries like Spain and ItalyDaniel Gros, Director CEPS, 17 January 2006A most impressive list of Board of Directors....

Roberto Castelli, justice minister, said the league planned to present concrete proposals for restoring Italy's former currency at a party meeting on June 19.
"Are Swedes poor because they are the outside the euro?” Mr Castelli asked at a conference in Milan.
Financial Times 8/6 2005

“Does sterling have no economic foundation because it is outside the euro? Is Denmark living in absolute poverty because it is outside the euro?

The anger and embarrassment of other politicians at the league's campaign are tempered by the recognition that the party's purpose is to attract maximum attention as Italy prepares for a general election next year.
In particular, the league wants to discredit Romano Prodi, the centre-left opposition leader who, as Italy's premier from 1996 to 1998 and later as European Commission president, was responsible for taking Italy into the eurozone.

Silvio Berlusconi says Mr Prodi's government fixed the lira against the euro at too high an exchange rate, a problem compounded in Mr Berlusconi's view by the euro's subsequent strength against the dollar and by the European Central Bank's monetary policy.